Compare and contrast the role that it plays in the Classical approach and Keynes’ approach. Draw the implications for the design of monetary and fiscal policies to stabilize an economy. One of the most highly contested and controversial economic concepts is Say’s law, or the law of markets, an economic theory associated with French economist and businessman Jean-Baptists Say. The law itself is embedded in ambiguity, and is usually associated as being one of the underlying assumptions in classical economics.
Say’s law is frequently described as ‘supply creates its own demand’ which is a term that was made famous by John Maynard Keynes in his General Theory. This essay however, will use a comparative study of both the the role of Say’s law in a classical approach and a Keynes’ approach to attempt to learn what classical economists such as J. B Say, Adam Smith, David Richard, and James Mill were actually trying to understand through the application of Say’s law before Keynes’ misinterpretation of the law made it a largely ambiguous term.
To achieve this, firstly, his essay will analyses the law itself and the assertion that production creates demand, as the income generated from the original production of a good or service can then be used be used to finance other purchases in the market (Skates, 1998, p. 2). Secondly, this essay will analyses what relationship Say’s law has with recession, unemployment, and general gluts. Before finally, using the information that has been provided to make an informed Judgment on what Say’s law actually means, and how it can be used as a macroeconomic tool when looking to stabilize the economy.
The reason to why Say’s law is so highly contested can be understood by realizing its ambiguous nature. When the the Classical school created the theory, they were not creating a single, unique law, but rather a collection of complex ideas in response to mercantilism. The Classical economists focused on the real sector of the economy, and viewed money as an intermediary good which is only used to facilitate production and exchange.
They also believed that excessive levels of saving wouldn’t reduce demand, as it would eventually be injected back into the economy in the form f investment, which would then lead to production, and ultimately wealth creation which would then create to purchasing power (Bamboo, 1999, p. 196). Moreover, this meant that the role of Say’s law in Classical economics was one which focused on the relationship between production and income. Skinner (1967, p. 57) observes this and points out that the original formulation of Say’s law was central to international trade. Say believed that if two nations are trading commodities, then those nations must first produce their own commodities before they have the power to purchase ACH others commodities. This is where one of the central points in Say’s law comes the other, then trade will be limited, not because of overproduction, but because of underproduction in the other country, thus creating a system where issues are caused by a failure of supply.
According to Say’s law this principle can be applied to any market. Ultimately, what this implies is that the production of goods and services will generate enough income so that other commodities can be purchased, it is the idea that one must first produce before they can purchase. Therefore, general gluts that supposedly occur when supply exceeds demand cannot happen, nor will the economy head towards a recession if there is a lack of demand (Stilwell, 2012, p. 67).
Thomas Malthusian however, opposed this idea as he believed that the reverse is actually true, and an overall decline in effective demand will lead to an overall decrease in economic activity. Unlike David Richard and James Mill who believed that gluts of certain commodities could occur, but ‘general’ gluts could not, Malthusian believed that a general glut could occur ‘because the demand of those employed in productive activities can never alone furnish a motive to the accumulation of capital’ (Veggie and Greengrocer, 2003, p. 132).
However, it was John Maynard Keynes who first coined the term ‘supply creates its own demand’ which has been glued to the assertion of Say’s law ever since. The statement originally came from Keynes’ General Theory in the passage – ‘From the time of Say and Richard the classical economists have taught that supply creates its own demand; meaning by this in some significant, but not clearly defined ensue that the whole of the costs of production must necessarily be spent in the aggregate, directly or indirectly, on purchasing the product’ (Keynes, 1936, p. 16).
In overview, it seems that the role of Say’s law was never intended to be one specific idea such as ‘supply creates its own demand’, but more the underlying assumption for classical economists that production creates purchasing power, and savings is only temporary as rational individuals wont hoard money. Keynes’ however, used the General Theory to manipulate what Say’s law was perceived to be in attempt to undermine classical economics as a whole.